Drawing a New Line

We’ve all noticed in the brokerage lobbying efforts an emphasis on rules over principles.  Tell us exactly what we can and cannot do, say the brokerage and independent broker dealer firms, in as much detail as possible, and we’ll have teams of compliance experts working hard to keep our reps and brokers inside those lines.  We’re the good guys; we take seriously making sure there are no fraudulent activities taking place in our shop, compared with the bucket shops and Bernie Madoffs of the world.

I don’t think the regulators or Congress have paid enough attention to the distinction between legal and harmful, and the sales organizations have taken flagrant advantage of this.  Barney Frank, the formerly influential Congressional representative who lent his name to the Dodd-Frank Act, famously exclaimed that much of what the brokerage firms did in the runup to 2008 was totally legal.  Let’s remember that this included the infamous Abacus deal, where a big client of Goldman Sachs was invited to put terrible securities inside the “investment” and then, after it was sold to unsuspecting customers, he was invited to bet against its survival. 

And, more to the point, it includes all those stories that I told in the “Real Cost(s) of Suitability article, where real, permanent damage was inflicted on unsuspecting customers of brokers who sold them high-commission junk when what they needed was a little financial guidance.  None of them will ever recover from these “legal but harmful” sales pitches that the brokers provided under the guise of advice.

If the regulators, state and federal, were focused on harm, in the broadest sense, then they would recognize that the commission incentives embraced by the wirehouses, and the sales contests and sales culture in general all turn the broker’s head away from benefiting the consumer, toward gathering assets and selling products which will generate the most profits for broker and firm.  You never see a contest for who can benefit customers the most, who can give them the best advice that will get them the most comfortable retirement—and isn’t that, in itself, revealing?

If today’s brokers can inflict harm legally, by selling non-traded REITs or managing assets in expensive, low-return privately-managed accounts, or selling “investment opportunities” that were created to blow up in the investors’ faces, then you could argue that our laws need to draw that line between what can and cannot be done more sharply.  Yes, of course we need to have laws against Ponzi schemes and selling stock in nonexistent companies.  The brokerage firms and independent broker-dealers should be applauded, I suppose, for rigorously making sure their brokers and reps don’t form bucket shops and openly commit fraud.  But don’t we also want to prohibit brokers from selling investments that are created to benefit them more than the customer?  After all, this “advice” they give can be the difference between a life of prosperity and a retirement in poverty.  The stakes are enormous for ordinary consumers.

Perhaps it’s time for our lobbyists to talk about ways that we can redraw the lines between what is right and what is wrong, between what is beneficial for the consumer and what is harmful.  If what is legal today is also harmful, then we’re simply not drawing the line sharply enough.

The SEC seems to be struggling with this issue, trying to signal to the brokerage industry with its recent proposals that it wants them to put clients’ interests first—without, of course, actually requiring them to.  But we know from experience that brokers and reps, with the encouragement of their firms, will lean over whatever line is drawn, with their feet right up against it—and we know that this space close to the line is where harm occurs.  The boundary where customers and clients will benefit from their services, the boundary that would genuinely protect the public, is well behind where they’re standing.

Please don’t get me wrong.  I think we should give at least one cheer (but no more) for firms that scrupulously try to stay on the right side of the law.  But today, alas, following the law is a very low bar when it comes to protecting the public from harm.  But when the brokerage firms talk about how much time and energy, and money, they spend on compliance, our lobbyists should ask about the contests that brokers can win if they do the very best job helping their clients live a prosperous, fulfilled life from now through retirement.  Until we see those replace the sales contests, we won’t see the end of the harm that commission-motivated brokers and reps do to their customers.